Thursday, October 31, 2013

We have been discussing the value of TICs from a financial standpoint, but like most private placement investments, there are many other factors to consider than just the numbers. TICs have a wide array of problematic features that retail investors might not think to look for.

For example, most TICs require unanimous consent of all investors for major decisions regarding refinancing or selling the property. A TIC can be sold to up to 35 investors, making unanimous consent extremely difficult. Short of owning a property outright, no other real estate investment is subject to this type of provision.

We have also seen TICs that involve sale-leaseback transactions on the underlying property. Sale-leaseback agreements are common real estate transactions whereby the owner of a property sells it to an investor and then leases it back to continue using it. After reaching a high of $6.6 billion in 2007, sale-leaseback transaction volume feel to $450.9 million in 2009. Volume has since improved reaching $1.8 billion in 2011.1

Sale-leasebacks can give investors a steady stream of income (the lease payments) and give the owner an upfront cash flow (by selling the property). Sale-leaseback transactions are marketed as a way for sellers to invest in their core business and transfer real estate risks to real estate investors. However, sale-leasebacks can also be a way for tenants to obtain financing. Since the seller and the tenant are the same entity, a sale-leaseback transaction makes it possible for sellers/tenants and TIC sponsors to agree on a sales price higher than the fair market value of the property in exchange for rent payments that are higher than market rent rates. TIC investors may be unaware that the property that they are buying was the subject of a sale-leaseback transaction. If the purchase price of the property by the TIC is above its market value, then TIC investors have effectively loaned the seller the excess amount. This type of arrangement can be used by tenants who cannot obtain from traditional sources, and may have a higher risk of default or vacancy.

We have seen sale-leaseback based TICs that paid above-market prices for the property. One incentive for them to do so is that a larger purchase price means they can attract more equity seeking a 1031 exchange. Because TIC sponsors are paid fees as a percentage of equity, they could use sale-leasebacks at below-market lease rates in order to increase their fees.

These are just a few examples of issues that plague TIC interests. The fundamental issue, however, is that unregistered private placement investments have a tremendous degree of flexibility in what they can offer to investors. Retail investors, even when familiar with publicly traded securities, may not be prepared for the additional complications that can have a major impact on private placement investments.

__________________________________1 Data is from Real Capital Analytics, as quoted in CBRE’s 2012 Special Report “U.S. Sale/Leasebacks: Unlocking Value” (PDF). Data includes transactions valued over $2.5 million in office, industrial, and retail property.

To answer that, we examined 194 sets of offering documents for TICs sold from 2004-2009. This totaled $2.2 billion in equity, which amounts to approximately 19% of all equity issued by TICs in that period, and included properties from 32 states.

Year

Name

Issuer

State

Equity (MM)

2005

Atlantic Boulevard

DBSI

Florida

$4.99

2007

Beacon Point

DBSI

Ohio

$3.60

2008

Belton Town Center

DBSI

Missouri

$3.62

2006

Colonnade at West Lake

DBSI

Texas

$4.95

2007

Colony Commons

DBSI

Texas

$3.67

2008

Houston Levee Galleria

DBSI

Tennessee

$9.80

2004

Southtrust Tower

DBSI

Florida

$34.24

2006

East 21st Street Buildings

DBSI

Kansas

$11.28

2005

Friar's Branch Crossing

DBSI

Tennessee

$7.82

2007

Goshen Village

DBSI

Indiana

$4.74

2007

Haverford Place

DBSI

Kentucky

$7.15

2005

Lakeview & Sojourn Centers

DBSI

Texas

$16.65

2008

Landmark Towers

DBSI

Minnesota

$16.50

2008

North Stafford

DBSI

Virginia

$13.22

2006

Northpointe Tower

DBSI

Missouri

$6.74

2007

Park Plaza Retail Center

DBSI

Texas

$8.30

2008

Peachtree Corners Pavilion

DBSI

Georgia

$3.95

2008

Pinehurst Square East

DBSI

North Dakota

$10.15

2008

Pinehurst Square West

DBSI

North Dakota

$6.36

2005

Renaissance Center

DBSI

Tennessee

$13.21

2004

Republic

DBSI

Texas

$18.10

2008

Romence Village

DBSI

Michigan

$6.51

2007

Sherwood Village

DBSI

Texas

$1.94

2008

Shoppes at Trammel

DBSI

Georgia

$3.72

2007

Shops @ Katy

DBSI

Texas

$4.88

2006

Silver Lakes

DBSI

Florida

$7.10

2007

Village at Old Trace

DBSI

Georgia

$9.42

2007

Willow Bend

DBSI

Tennessee

$2.87

2008

Wisdom Pointe

DBSI

Georgia

$3.35

2006

Bridford Lake Apartments

Core Realty Holdings

North Carolina

$10.13

2006

Brookfield Lakes Corporate Center

Core Realty Holdings

Wisconsin

$32.00

2006

Cardinal Apartments

Core Realty Holdings

North Carolina

$6.34

2006

Chatham Wood Apartments

Core Realty Holdings

North Carolina

$4.39

2007

Governor's Pointe

Core Realty Holdings

Ohio

$8.13

2006

Hickory Creek Apartments

Core Realty Holdings

Virginia

$10.90

2007

Hidden Lakes Apartments

Core Realty Holdings

North Carolina

$10.50

2008

Hunters Chase Apartments

Core Realty Holdings

North Carolina

$4.93

2006

Madison at Adams Farm Apartments

Core Realty Holdings

North Carolina

$11.62

2008

Minneapolis Industrial Portfolio

Core Realty Holdings

Minnesota

$14.81

2007

Promenade at Northridge

Core Realty Holdings

California

$11.13

2006

Park West Apartments

Core Realty Holdings

Virginia

$9.89

2007

Revere Holdings

Core Realty Holdings

Nevada

$17.50

2006

Riverbend Apartments

Core Realty Holdings

Indiana

$30.50

2007

San Antonio Airport Industrial

Core Realty Holdings

Texas

$15.10

2006

Sonoma Ridge Apartments

Core Realty Holdings

California

$16.00

2005

West Michigan Industrial

Core Realty Holdings

Michigan

$23.60

2005

Westridge Executive Plaza

Core Realty Holdings

California

$8.50

2006

Westwind Office Park

Core Realty Holdings

California

$17.48

2007

Griffin Capital (Independence) Investors

Griffin Capital

Ohio

$13.10

2006

Griffin Capital (Naperville) Investors

Griffin Capital

Illinois

$14.33

2006

Griffin Capital (Q Street) Investors

Griffin Capital

California

$21.28

2006

Griffin Capital (St. Paul) Investors

Griffin Capital

Minnesota

$19.73

2006

Griffin Capital (Naperville) Investors

Griffin Capital

Illinois

$14.33

2007

Marriott Courtyard-Columbus Airport

Moody National Companies

Ohio

$10.81

2007

Marriott Courtyard-Columbus Downtown

Moody National Companies

Ohio

$5.85

2007

Marriott Courtyard-Lyndhurst

Moody National Companies

New Jersey

$19.22

2007

Marriott Fairfield Inn Meadowlands

Moody National Companies

New Jersey

$11.51

2007

Marriott Residence Inn-Perimeter Center

Moody National Companies

Georgia

$7.08

2007

Marriott Residence Inn-Torrance

Moody National Companies

California

$23.02

2007

Marriott SpringHill Suites

Moody National Companies

Washington

$5.83

2008

Marriott TownePlace Suites-Portland

Moody National Companies

Maine

$9.69

2007

Fairfield Inn Denver (Denver One)

Moody National Companies

Colorado

$8.63

2006

Philips Office

Moody National Companies

New Jersey

$21.04

2007

Renaissance Meadowlands

Moody National Companies

New Jersey

$22.39

2007

TownePlace Suites Fort Worth

Moody National Companies

Texas

$4.58

2007

TownePlace Suites Mount Laurel

Moody National Companies

New Jersey

$5.60

2006

Weatherford Plaza

Moody National Companies

Texas

$9.53

2007

Beamer Place Apartments

Geneva

Texas

$10.16

2005

Bridle Creek Apartments

Geneva

Kentucky

$13.79

2006

Chesterfield Valley Medical Office Building II

Geneva

Missouri

$8.15

2008

Cooper Glen Apartments

Geneva

Texas

$6.44

2005

Honey Creek Corporate Center II

Geneva

Wisconsin

$11.92

2006

Honey Creek Corporate Center III

Geneva

Wisconsin

$10.45

2007

International Market Square

Geneva

Minnesota

$13.63

2007

Carrington Ridge Apartments

TIC Properties

Georgia

$8.55

2007

Duncan Distribution Center

TIC Properties

South Carolina

$7.25

2007

TIC N. Central Dallas Investors

TIC Properties

Texas

$5.95

2007

SBC Fenton

TIC Properties

Missouri

$6.90

2006

Acropolis Office Park

TIC Properties

Ohio

$11.95

2005

Southfield Office Building

TIC Properties

Texas

$8.85

2006

302 West Third Street

TIC Properties

Ohio

$8.54

2007

NNN 824 North Market Street

Triple Net Properties

Delaware

$15.00

2007

NNN Central Plaza

Triple Net Properties

Arizona

$32.80

2007

NNN Darien Business Center

Triple Net Properties

Illinois

$13.20

2007

NNN Eastern Wisconsin Medical Portfolio

Triple Net Properties

Wisconsin

$12.94

2007

NNN Exchange South

Triple Net Properties

Florida

$12.34

2007

NNN Harbour Landing

Triple Net Properties

Texas

$7.38

2008

NNN Jacksonville Medical Plaza

Triple Net Properties

Florida

$14.04

2007

NNN Mainstreet at Flatiron

Triple Net Properties

Colorado

$5.85

2007

NNN Old Line Professional Centre

Triple Net Properties

Maryland

$6.65

2007

NNN One Ridgmar Centre

Triple Net Properties

Texas

$11.85

2007

NNN River Ridge

Triple Net Properties

North Carolina

$10.85

2008

NNN Six Forks Station

Triple Net Properties

North Carolina

$11.70

2007

NNN Three Resource Square

Triple Net Properties

North Carolina

$11.48

2008

NNN Washington Park

Triple Net Properties

Ohio

$12.07

2006

116 Defense Highway

Direct Invest

Maryland

$7.62

2007

246 Omni Way

Direct Invest

Massachusetts

$12.59

2007

2810 North Parham Road

Direct Invest

Virginia

$7.82

2007

500 East Main

Direct Invest

Virginia

$16.90

2007

Braintree Park

Direct Invest

Massachusetts

$21.94

2008

Heron Cove

Direct Invest

New Hampshire

$10.63

2007

Cummings Research Park - Portfolio II

Bluerock Real Estate

Alabama

$21.28

2007

Summit at Southpoint

Bluerock Real Estate

Florida

$13.55

2008

1600 Barberry Lane

Grubb & Ellis

Georgia

$19.07

2008

5001 Enclave

Grubb & Ellis

Texas

$11.22

2008

Oak Park Office Center

Grubb & Ellis

Texas

$18.65

2008

2650 Old Norcross

Grubb & Ellis

Georgia

$13.66

2008

One Live Oak

Grubb & Ellis

Georgia

$17.49

2008

Plantations at Haywood

Grubb & Ellis

South Carolina

$21.36

2008

7207 Snowden Road

Grubb & Ellis

Texas

$12.36

2008

1650 Sunflower

Grubb & Ellis

California

$14.93

2008

5200 Upper Metro

Grubb & Ellis

Ohio

$6.33

2007

Houston Office Buildings

Argus Realty Investors

Texas

$13.62

2008

IBP

Argus Realty Investors

Texas

$55.00

2007

Hendersonville

Desanto Realty Group

Tennessee

$13.32

2007

Cypress Medical

Desanto Realty Group

Kansas

$10.81

2007

Clearview

Desanto Realty Group

Michigan

$9.91

2007

Fox Chase

Desanto Realty Group

Ohio

$9.77

2008

Hunter’S Chase

Desanto Realty Group

Ohio

$11.44

2007

Perry's Crossing

Desanto Realty Group

Ohio

$10.07

2007

Ashtabula Acquisition

Cabot

Ohio

$15.10

2007

Northpark Southland Acquisition

Cabot

Indiana

$22.00

2007

Creekside Acquisition

Cabot

Georgia

$17.50

2005

Trafalgar/Avion Acquisition

Cabot

Florida

$10.70

2007

Fontaine Business Park

U.S. Advisors

South Carolina

$11.50

2004

North Valley Tech Center

Argus Realty Investors

Colorado

$20.20

2006

Triwest Plaza

Argus Realty Investors

Texas

$17.00

2005

Covington Lansing Acquisition

Direct Capital Securities Inc.

Michigan

$7.38

2005

Covington Montelago Acquisition

Direct Capital Securities Inc.

Texas

$9.72

2007

Courtyard Matthews & Courtyard Rock Hill

Oxford Capital Group

North Carolina

$10.33

2007

Residence Inn & Courtyard by Marriott

Oxford Capital Group

South Carolina

$11.68

2006

Residence Inn by Marriott - Chantilly

Oxford Capital Group

Virginia

$13.05

2007

Residence Inn Charleston

Oxford Capital Group

South Carolina

$7.50

2007

SpringHill Suites Riverview

Oxford Capital Group

South Carolina

$5.52

2007

Crystal Lake & Pelican Pointe

Cabot 1031

Florida

$13.00

2007

East Town Acquisition

Cabot 1031

Wisconsin

$7.10

2006

Oak Grove Acquisition

Cabot 1031

Florida

$8.65

2007

Turfway Ridge Acquisition

Cabot 1031

Kentucky

$11.75

2007

Portland Senior Properties

Christopher Place

Oregon

$4.60

2007

Traverse Bay Senior Properties

Christopher Place

Michigan

$4.00

2006

DFW Office/Flex I

Equitable Companies

Texas

$10.85

2008

Evanston Portfolio

Equitable Companies

Illinois

$9.49

2006

DFW Office/Flex II

Equitable Companies

Texas

$12.75

2006

Barrett Woods Corporate Center

Exchange Point Properties

Missouri

$9.49

2008

Cameron Brook Apartments

Exchange Point Properties

Georgia

$17.17

2007

Mapleridge Shopping Center

Exchange Point Properties

Minnesota

$7.72

2007

Southridge Plaza

Exchange Point Properties

Texas

$6.47

2007

Dobson Ranch

Geyser Holdings

Arizona

$4.90

2009

Keaau Hawaii

Geyser Holdings

Hawaii

$4.33

2008

Showplace

Geyser Holdings

Indiana

$5.59

2007

Yuma

Geyser Holdings

Arizona

$6.00

2006

Springs - Office Investors

Meridian

Kentucky

$15.39

2006

Atlanta One

Moody National Companies

Georgia

$7.21

2006

Memphis Residence Inn

Moody National Companies

Tennessee

$6.93

2006

Residence Inn Lebanon

Moody National Companies

New Hampshire

$9.36

2006

Texas Two

Moody National Companies

Texas

$9.30

2008

Madison At Fairwood Apartments

Passco Companies

Washington

$16.90

2006

121 Airport Centre I & II

Principle Equity Management

Texas

$16.87

2007

Johns Creek Office Portfolio

Principle Equity Management

Georgia

$12.64

2007

Technology Parkway Office Portfolio

Principle Equity Management

Georgia

$13.30

2005

Thistle Landing

Principle Equity Management

Arizona

$22.35

2007

University Shopping Center

Principle Equity Management

Texas

$7.56

2005

Baylor Garland Medical Plaza

Rainier Capital Management

Texas

$5.60

2006

Business Exchange

Rainier Capital Management

Missouri

$3.19

2007

Enclave Parkway

Creekstone Partners

Texas

$11.54

2007

Woodlands

Creekstone Partners

Texas

$7.36

2004

Cypress Pointe IV

Mammoth Equities

California

$14.65

2005

Professional Building - Roseville

Mammoth Equities

California

$7.72

2007

Vista Ridge

Sequoia

Texas

$9.39

2007

Forum

Sequoia

Texas

$12.00

2006

The Best Western Airport Inn Fort Myers

Gibralter Holdings

Florida

$10.69

2006

Maunakea Marketplace

Gibralter Holdings

Hawaii

$6.30

2008

Algonquin Galleria

Nelson Bros.

Illinois

$9.54

2006

Pueblo Crossing I

ORIX EMPIRE

Colorado

$6.00

2007

Kansas City

ORIX EMPIRE

Missouri

$8.60

2007

Battle Creek I

ORIX EMPIRE

Oklahoma

$14.00

2006

Fountains II And Fountains III

Wilkinson

Illinois

$7.01

2006

State Of Michigan Building

APCA

Michigan

$3.69

2007

Landmark/Laumeier Office Portfolio

Bluerock Landmark

Missouri

$7.53

2008

Meadow Green Apartments

Delmar Equity Partners

Texas

$2.40

2007

Colonnade At King’S Grant Shopping Center

Kodiak

North Carolina

$3.85

2007

Hotel Indigo Peachtree Street

Pennbridge Capital

Georgia

$8.40

2006

RMC AutoSonic BMWN League City

RMC Property

Texas

$9.95

2007

Selina Plaza

TIC Capital

Florida

$2.54

2006

State Farm Insurance Building

TIC Capital

California

$7.05

2008

2801 East Enterprise Drive

Whitecap Real Estate

Wisconsin

$2.38

2006

Rambling Oaks Assisted Living And Rambling Oaks Courtyard

Wilkinson 1031

Oklahoma

$7.20

2007

Northgate Business Center And Blackhawk Corporate Center

Argus Realty Investor

Arizona

$20.55

2006

220 Virginia Avenue

Triple Net Properties

Indiana

$20.76

2005

Sixth Avenue West

Triple Net Properties

Colorado

$6.60

2005

Woodside Corporate Park

Triple Net Properties

Oregon

$24.65

2006

Las Colinas Highlands

Triple Net Properties

Texas

$15.40

2007

Laveen Village Marketplace

Passco Companies

Arizona

$8.50

2005

Legacy

RMC Property

Texas

$9.78

After we compiled this information, a couple of things stood out. We have said before that TICs tend to have high upfront fees. In our database, the average upfront fees totaled 28% (!) of total equity. The lowest upfront fees were a still-high 17%, and the highest was a remarkable 72%. We have also said that TICs tend to be highly leveraged (i.e., use a lot of debt). Some TICs had no leverage, but both the average and median debt-to-equity ratio (total debt / total equity) across our sample was 1.56.

We've also talked about how TICs tend to have low net present values, even taking a sponsor's projected cash flows at face value. When we valued all the sponsor's projections in our database, we found that the average TIC was worth only 83.6 cents on the dollar.1 But were the sponsors' assumptions valid?

For each property, we compared the cap rate used by the sponsor to cap rates published by a real estate market analysis firm. Cap rates are used to estimate the final value of the property at sale. The lower the cap rate, the higher the resulting property value. We found that sponsors tended to use cap rates that were lower than market rates, inflating the property value at sale, as shown in the figure below (Figure 10 in the paper):

When we value all of the properties using market cap rates rather than those assumed by the sponsors, the average present value drops to 74.5 cents on the dollar. The distributions of present values before (blue) and after (red) correcting the sponsor's caps are shown below (Figure 12 in the paper):

These results suggest that TIC sponsors use aggressive assumptions when preparing cash flow projections for offering materials. These cash flows are the primary justification for projected distributions and investor returns, yet even a relatively straightforward discounted cash flow analysis reveals that most TICs were exceptionally poor investments.

______________________________1 Sponsors often include multiple projections, especially for cap rate assumptions. We valued each of these alternative projections and averaged the resulting values.

Tuesday, October 29, 2013

For our second post of TIC Week, we would like to describe how to calculate purchase-date valuations of TICs. The vast majority of TIC offering documents include cash flow projections. As we described last week, we can use discounted cash flow analysis to determine the present value of the property based on those projections. While the cash flows from TIC investments are more complicated than those of simple coupon-paying bonds, the underlying analysis is essentially the same.

Discounted cash flow analysis
A TIC investor's contributed capital buys her a fraction of the undivided property securitized and sold as a TIC investment. The investor is entitled to a proportional fraction of the TIC's annual distributions, as well as her proportional share of the property's net sales proceeds at the end of the holding period. These are analogous to the periodic interest payments and principal repayment on a bond, respectively, except that the amount of these cashflows varies based on certain assumptions, such as vacancy rate and rent growth rate (to name just a few).

To help illustrate our TIC valuation methodology we have created a free Excel spreadsheet that calculates the present value of a TIC investment per each $1 spent by investors. We use a stylized example of a real-world TIC to illustrate our methodology.

The TIC in our example obtains $20.5 million from TIC-owners and a mortgage loan for $37.7 million. The loan is interest-free for the first two years and pays an annual interest rate of 6.1%. The TIC buys a property for $51.4 million, pays $3.2 million in upfront fees, and sets aside $3.7 in upfront reserves. The projected base rent of the property is $5.4 million for the first year, with a 4% annual growth rate. Vacancy is expected to be 5% of base rent and expenses are expected to be 34% of base rent. Our TIC plans on holding the property for 10 years. At the end of the holding period, the TIC plans on selling the property for an estimated price of $60.9 million, obtained from dividing the Net Operating Income (NOI) projected for year 11 divided by the 8% cap rate at sale. The sale of the property incurs in fees that are projected to be 6% of the property purchase price. To calculate the present value of the TIC (as in our earlier post), we need to determine the discount rate that should be applied to the TIC cash flows. We obtain discount rates that vary with the risk-free rate and the TIC's leverage -- that is, the relative size of its mortgage loan and investors' contributed capital. Refer to our research paper (PDF) for more information on the literature supporting our methodology.

With these basic parameters, we project cash flow distributions to investors. In our experience valuing close to 200 TICs, TIC sponsors use reserves to keep the annual distributions as a fraction of investors' contributed capital (a ratio that TIC sponsors term "cash-on-cash" returns) close to 7%. Net proceeds from property sale is calculated after taking into account sales fees, any left-over reserve balances, as well as the mortgage balance.

We discount annual cash flows as well as the proceeds from the property sale to obtain the present discounted value of cash flows to investors. Dividing the total projected discounted cash flows by the investors' contributed capital, we arrive at the purchase date value per $1 spent. For our example TIC, investors suffer a purchase-date loss of $6.2 million, roughly 30% of their investment. In other words, the TIC is worth only 70 cents for every dollar of contributed capital by investors. As we will discuss in our post tomorrow, we find that using the unmodified projections developed by the sponsors, most TIC investors suffered purchase-date losses of 10-30% of their investment.

Sensitivity analysis
One of the major criticisms of TIC investments is that the sponsor's cash flow projections very often assume unreasonably aggressive assumptions for key parameters. Typically, the cash flow projections included in the offering documents can be used “as-is” in calculating baseline purchase-date valuations, and then we can modify each of those assumptions in turn to see their effect on the projected value of the property.

In our spreadsheet, for example, if we determine that the actual market vacancy rate is 10% rather than 5%, we can change the value in the vacancy rate cell and see the effect on the net present value. A higher vacancy leads to lower projected revenue throughout the holding period and for the year after the holding period ends, lowering both annual projected cash flow distributions and projected proceeds from property sale. With a 10% vacancy rate, the TIC is now worth only 59 cents for every dollar of contributed capital.

Our Excel spreadsheet can be modified to value the vast majority of TICs. The cells with orange backgrounds are inputs and can be tailored to the specific TIC investment you may be interested in valuing. We include inputs relating to the property purchase, rent and expenses, capital sources, property sale, and discount rate.

Implications
Many investors suffered crippling losses in TICs. Some may argue unconvincingly that the unforeseeable real estate crisis is to blame. But the reality is, that even at the time of issuance, the vast majority of TICs were lousy investments. The sponsor-developed projections implied large purchase-date losses, even taking the sponsor assumptions at face value, in the face of even a simple discounted cash flow analysis. In our work, we've found that many sponsors used aggressive assumptions to support unrealistically optimistic valuations.

We think that the incomplete risk-return analysis that investors received, as well as the large sales commissions charged by the independent broker dealers that pushed these products to their investors were some of the key drivers of the TIC industry's growth. Investors should be wary of TICs and any other similar investments.

Monday, October 28, 2013

Today, SLCG posted a new research paper, Large Sample Valuations of Tenancies in Common (PDF). In it, we value 194 TICs, totaling $2.2 billion in equity and representing approximately 17% of the TIC industry from 2004 to 2009. Our paper complements our earlier research on TICs (available here and here), and is the most extensive empirical study of TICs to date. This week we will be summarizing the results of our research in a series of blog posts. But to start, let’s address some basic questions about TICs.

What are TICs?
TICs are real estate investments owned jointly by two or more entities. The real estate is undivided, meaning that no particular tract of the land or building on the land can be identified as belonging to a particular entity. While TICs can result from family gifting when a property is inherited by multiple family members, for example, our focus is on syndicated TICs sold to retail investors. Syndicated TICs are private placement real estate investments that are packaged and sold by professional real estate sponsors.

The vast majority of TICs purchase an income-generating property with the proceeds from an equity issuance and a mortgage loan. TICs anticipate holding the property for a period of several years (typically 7-10 years), throughout which they pay monthly distributions to TIC investors as well as any interest and principal due on the loan. TICs are designed to sell their property and distribute the sales proceeds to investors after paying the outstanding mortgage balance and sales fees.

Why did real estate investors purchase TICs?
TICs were sold as a way to defer capital gains taxes on the sale of real estate property. Capital gains taxes are typically due at the time of the sale of a business or investment property if the sale produces a gain. However, Internal Revenue Code’s rule 1031 allows the payment of taxes to be postponed if the sales proceeds are used to purchase similar property or what is known as a “like-kind exchange.” TIC issuance increased dramatically after 2002, when the IRS adopted Rev. Proc. 2002-22 (PDF) “clarifying when acquisition of a tenant-in-common interest in real estate qualifies as replacement real estate under Section 1031.”

How much TIC equity was sold over the years?
The total amount of equity invested in TICs increased from $167 million in 2001 to $3.7 billion in 2006. After 2007, many TICs stopped paying distributions to equity investors. It was not uncommon for non-performing TICs to undergo loan refinancing that effectively wiped out the value of the equity interests. The industry shrank precipitously from 2007 to 2009 and, with $278 million issued in 2012, is currently a small fraction of what it used to be. The following figure shows the equity invested in TICs from 2001 to 2012.

Equity Invested in TICs

What are some of the problems with TICs?
TICs charge investors high upfront fees on the order of 15% to 30% of gross offering proceeds, often more than offsetting the benefit of capital gains tax-deferral. In addition, TIC offering documents are often misleading and incomplete. Their financial projections compute “cash-on-cash” return rates that often include repayment of contributed capital held in reserves in what appears to be income. TIC sponsors often use aggressive assumptions in their cash flow projections that mislead investors into expecting higher than reasonable returns.

A final judgment was entered against Huakang Zhou (a/k/a David Zhou) and Warner Technology and Investment Corporation for their alleged involvement in "a scheme to list one client on a national securities exchange through manipulative trading and by facilitating in effect an artificial shareholder base sufficient for listing." The final judgment permanently enjoins Zhou and Warner Investment from future violations of the securities laws and orders them to pay over $1.4 million combined in disgorgement, prejudgment interest, and civil penalties. The final judgment also bars the defendants from "association with any investment adviser, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock, with the right to apply for reentry after five years."

A verdict was entered by jury this month against Todd A. Duckson, Capital Solutions Monthly Income Fund, LP, and Transactional Finance Fund Management LLC, "a company owned by Duckson that became the fund's investment advisor in November 2008." The defendants were found guilty of violating various provisions of the securities laws based on the SEC's complaint that "alleged...the defendants engaged in securities fraud in connection with their offer and sale of interests in the Fund."

This week the SEC filed an application for "an order to enforce investigative administrative subpoenas served on Michael Grosso in conjunction with securities being sold related to BHJ Brokerage and Consulting Firm, LLC." According to the SEC, a Formal Order Directing Private Investigation was previously issued and "Grosso has failed to comply with validly issued and served subpoenas for his testimony relating to this investigation."

A final judgment was entered against Aleksey P. Koval a/k/a Alexei Koval, for his involvement in an "insider trading scheme in which a former UBS investment banker," Igor Poteroba, "tipped Koval about eleven impending acquisitions, tender offers, or other business combinations." According to the complaint, Koval traded on this information and then tipped his friend, Alexander Vorobiev, who also allegedly traded on the information. In a parallel criminal proceeding, "Koval pleaded guilty to three counts of securities fraud, was ordered to pay a forfeiture of $1,414,290, and was sentenced to twenty-six months of imprisonment." The final judgment entered against Koval permanently enjoins him from future violations of the Exchange Act and finds him liable for over $1.2 million in disgorgement and prejudgment interest, which is deemed "satisfied by the criminal forfeiture order." Additionally, the SEC barred Koval "from association with any investment adviser, broker, dealer, municipal securities dealer, or transfer agent, and from participating in any offering of a penny stock, based on his criminal conviction in the parallel proceeding."

Earlier this month, a jury "returned a verdict against AIC, Inc., Community Bankers Securities, LLC, and Nicholas D. Skaltsounis on all counts." The SEC's 2011 complaint alleged that "Skaltsounis devised and orchestrated an offering fraud by offering and selling millions of dollars of AIC promissory notes and stock." According to the SEC, the defendants "misrepresented and omitted material information to investors relating to, among other things, the safety and risk associated with the investments, the rates of return on the investments, and how AIC would use the proceeds of the investments."

Prior to the trial, the court granted the SEC's motion for partial summary judgment and found in favor of the SEC on various claims against the defendants and also found in favor of the SEC on various claims against three relief defendants, "Allied Beacon Partners, Inc. (f/k/a Waterford Investor Services, Inc.), Advent Securities, Inc., and Allied Beacon Wealth Management, LLC (f/k/a CBS Advisors, LLC)." Additionally, prior to trial, co-defendants John B. Guyette and John R. Graves "entered into settlement agreements with the Commission." These agreements ordered injunctive relief, disgorgement, and civil penalties.

According to the complaint (PDF), Diebold, Inc., "a global provider of ATMs and bank security systems," paid approximately $3 million for "leisure trips, entertainment, and other improper gifts on foreign officials to obtain and retain lucrative business with government owned banks in China and Indonesia, and [paid] other bribes in connection with the sale of ATMs to private banks in Russia." Diebold has agreed to settle the charges by agreeing to a final judgment that permanently enjoins it from future violations of the securities laws, orders it to pay almost $23 million in disgorgement and prejudgment interest, and appoints an independent compliance monitor. "In a parallel criminal proceeding, Diebold has agreed to pay a $25.2 million criminal fine as part of a deferred prosecution agreement with the U.S. Department of Justice."

According to the complaint (PDF), Yuhe International, Inc., "a China-based provider of broiler chickens,"and its Chief Executive Officer, Gao Zhentao, "made false public statements concerning an acquisition Yuhe claimed to have executed in 2009." Furthermore, the SEC alleges that from 2009 through 2011, "Yuhe misled its public investors by disseminating a series of materially false statements concerning [the] purported acquisition of additional chicken farms for more than $15 million, often providing updates concerning the farms' integration and contribution to the company's revenue." However, in reality, "the acquisition never occurred." The complaint charges the defendants with violating sections of the Securities Act and Exchange Act and seeks permanent injunctions, civil penalties, disgorgement, prejudgment interest, an officer-and-director bar against Gao, and other relief.

When determining the value of a bond, you start by thinking about the cash flows you're expected to recieve and when those cash flows are expected to occur. We've created the following illustration of a simple $1,000 face-value bond that pays annual interest payments (also known as coupons).

UndiscountedDiscounted

Coupon Rate:

Term:

Discount Rate:

For a year $1,000 face-value bond with an interest rate of , the total cash flow is . The sum of discounted cash flows is .

The timing of the cashflows matters since obviously we'd prefer to have a dollar today than a dollar tomorrow. The value today of a future payment today is called the present value of that payment. We find the present value by discounting the future cash flow using a discount rate for an asset that matures at approximately the same time. $$Present Value = {Cash Flow \over \left(1 + Discount Rate\right)^{Time}}$$ For example, if we use an interest rate of 3% to discount our cash flows, then a $30 coupon payment at the end of year one has a present value of $30/(1+3%) = $29.13. A $30 coupon payment at the end of year two has a present value of $30/((1+3%)*(1+3%)) = $28.28. The total value of the bond is equal to the sum of the present values of the coupon payments.

The present value of the payments an investor is expected to receive is dependent upon the interest rate with which those cash flows are discounted. As the discount rate increases, the value of the payments (and therefore the value of the security) goes down. As the discount rate decreases, the value of the payments goes up.

Thursday, October 24, 2013

When brokers sell unsuitable investments to their clients, it is often the case that those clients will sue the broker and the brokerage firm, a process known as 'broker-customer disputes.' What is less common is for brokers to sue the brokerage firm -- their own employer -- for encouraging them to sell risky investments that caused losses for their clients.

In a recent, closely-watched FINRA arbitration, Michael Farah of Newport Beach, California won approximately $4.3 million from his former employer, Wedbush Securities, for misrepresenting the riskiness of collateralized mortgage obligations (CMOs) he sold to clients. The award included $1.4 million in punitive damages. Our own Dr. Craig McCann testified on behalf of Mr. Farah, and has testified on behalf of the clients in arbitrations that resulted from the sales. You can find the recent award here, and a related customer dispute here. The result has been picked up by both Reuters and, more recently, the Wall Street Journal.

CMOs are mortgage-backed securities similar to those that have been implicated in the 2008 financial crisis. You can learn more about CMOs from our 2008 primer (PDF). These securities have very complex interest rate and credit risk factors that are difficult for most unsophisticated investors to understand.

This result could lead to other similar disputes between brokers and their current or former employers. Many brokers have faced waves of customer complaints from selling risky securities both before and after the financial crisis, which could impact their standing with current or potential customers. It will be interesting to see if the risks of those securities was misrepresented to brokers as they often are misrepresented to customers.

Yesterday, the Securities and Exchange Commission (SEC) issued proposed rules (PDF) on crowdfunding to regulate the offer and sale of crowdfunding securities. The press release for the proposed rules can be found here. These proposed regulations are meant to fulfill the SEC's requirements under Title III of the JOBS Act (PDF). We have previously discussed the JOBS Act crowdfunding provisions in the context of real estate investments, but the proposed rules cover all types of crowdfunded investments.

Under the new rules, investors with annual income less than $100,000 could invest at most $5,000 with a particular issuer while investors with more than $100,000 in net worth or annual income could invest up to $100,000 (up to 10% of their annual income or net worth). Investors who do purchase crowdfunded securities would not be able to sell those securities for one year.

The proposed rules limit the aggregate amount of capital raised through the sale of crowdfunding securities to $1 million per twelve month period. Importantly, holders of these exempted securities would not count toward the total used to determine the registration requirement under the Exchange Act (PDF) -- requires registration for as few as 500 non-accredited investors. In addition, the proposed rules require companies to disclose information to the SEC and investors including: officer and director information, use of proceeds, description of financial condition, company's tax returns, etc. The SEC will collect comments on the proposed rules over the next three months.

Crowdfunding certainly presents an opportunity for abuse of unsophisticated investors. Many in the mainstream media are concerned that it will lead to a proliferation of highly speculative investments, but another concern is that the relatively small amount sold to each investor could limit potential redress in the event of fraud. It is unclear whether the SEC's disclosure requirements will be sufficient to detect crowdfunded fraud or what form enforcement would take in this context.

Tuesday, October 22, 2013

Leveraged and inverse exchange-traded funds (ETFs) are some of the most volatile securities traded in public markets. They are designed to track a specific index, except multiplying daily return of the index by a positive (leveraged) or negative (inverse leveraged) factor. The 'daily' part is important: leveraged and inverse ETFs do not track the leveraged or inverse return of the index for any period longer than a single day due to portfolio rebalancing. You can find more details about rebalancing risk in our review paper on the subject.

Despite these risks, leveraged and inverse ETFs continue to attract assets, sparking a robust debate about their potential impact on the broader market. One of the most hotly debated topics is whether ETF rebalancing causes distortions in market prices. Because of the way leveraged ETFs rebalance, they tend to purchase more of their underlying assets in rising markets and sell in down markets. If these purchases or sales are relatively large trades, this could push rising prices higher and falling prices lower, effectively increasing daily volatility of the underlying assets.

It is important to recognize that regardless of whether leveraged and inverse ETFs have a broader effect on markets, that they are highly risky to individual investors is not controversial. Most sources, including the issuers themselves, agree that leveraged and inverse ETFs are designed for traders and are not suitable for investors. And yet, we know from firsthand experience that long-term investors are being sold these products, suggesting that many brokers and advisers do not understand their inherent risks.

Monday, October 21, 2013

We often encourage investors to visit the Financial Industry Regulatory Authority's (FINRA) BrokerCheck system to check the record of their broker. The broker's record contains information about their qualifications, employment and complaint history. The completeness of the information contained within the complaint history has recently been called into question by the Public Investors Arbitration Bar Association (PIABA).

Last week, PIABA released a study (PDF) of over 1,600 arbitration cases filed from 2007 through the end of 2011.[1] For the time period under consideration, the study found that expungement was granted in the great majority of arbitration cases resolved by stipulated awards or settlements. As a result, the information contained in the CRD may be of limited utility to investors. According to the study's author, Scott Ilgenfriz, "[t]his clearly indicates that the current expungement procedures are seriously flawed. Regulators need to step in and crack down on the granting of expungements, particularly in settled cases."

The study mentioned one particular broker who requested expungement 40 times and was granted expungement by arbitration panels in nearly 88% of the cases. While expungement is meant to provide relief to brokers in extraordinary situations, this particularly egregious example highlights deficiencies in the implementation of FINRA's expungement process.

FINRA is considering taking steps to "provide additional guidance and training to arbitrators" and is "reviewing its rules and interpretations" in connection with expungements. Incomplete information contained on a broker's CRD entry could put investors at risk and allow dirty brokers to operate with impunity.

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[1]An expungement essentially removes any record of a complaint from a broker's entry on the Central Registration Depository (CRD).

Friday, October 18, 2013

A final judgment was entered against Ronald Baldwin, Jr., former CFO of JBI, Inc., for his alleged involvement in "a scheme to commit securities and accounting fraud in 2009." Previously, the SEC charged JBI, Inc. and its CEO, John Bordynuik for their alleged involvement in the scheme. Baldwin consented to the judgment which permanently enjoins him from future violations of the securities laws, orders him to pay a $25,000 penalty, and imposes a five-year officer-and-director bar against him.

The SEC charged 16 defendants as well as seven entities for their involvement in a "worldwide pyramid scheme targeting members of the Asian-American community." The defendants "falsely promised exponential, risk-free returns to investors in a venture that purportedly sold Internet-based children's educational courses." The defendants allegedly solicited investments "in an entity operating under the business name 'CKB' or 'CKB168,' which they claim is a rapidly growing and legitimate multi-level marketing company that purportedly sells web-based children's educational courses." In reality, however, CKB168 is "nothing more than a fraudulent pyramid scheme" and "CKB has little or no real-world retail consumer sales to generate the promised returns." The court granted the SEC's "request for a temporary restraining order, asset freeze, and other emergency relief against" the defendants. Additionally, the SEC seeks disgorgement, financial penalties, permanent injunctions, and other relief.

A default judgment has been entered against Peter Madoff for his involvement in the Bernard L. Madoff Investment Securities LLC ponzi scheme. The judgment permanently enjoins him from future violations of the securities laws, but orders "no monetary relief in light of Peter Madoff’s criminal conviction and the $143 billion in restitution ordered in the parallel criminal proceeding United States v. Peter Madoff."

Former Detroit Mayor Kwame Kilpatrick, Previously Sued by the SEC for Fraud, Sentenced to 28 Years in Prison, October 15, 2013, (Litigation Release No. 22844)

Last week the SEC announced that the court "sentenced former City of Detroit Mayor Kwame Kilpatrick to 28 years in prison." Kilpatrick had previously been convicted of "racketeering, conspiracy, fraud, extortion, and tax crimes in March 2013" by a jury. Kilpatrick is a defendant of a pending SEC civil injunctive action based on the same facts "alleged by the U.S. Attorney's Office."

A final distribution plan was approved for Fair Fund established in SEC v. Hochfeld et al. The SEC "charged Berton M. Hochfeld and his entity Hochfeld Capital Management, L.L.C. with securities fraud for misappropriating assets and making material misstatements to investors in the Heppelwhite Fund, L.P., a now defunct hedge fund." Previously, the court entered judgments ordering injunctions, an asset freeze, disgorgement, and civil penalties. "To date, the SEC has collected approximately $6.2 million for the Fair Fund pursuant to the Final Distribution Plan."

According to the complaint (PDF), Michael R. Enea operated a $2.1 million Ponzi scheme, "conducting fraudulent, unregistered offerings of securities and misappropriating investor funds to pay his personal expenses." Enea has agreed to a final judgment that permanently enjoins him from violating the Securities Act and Exchange Act, and orders him to pay over $843,000 in disgorgement.

Thursday, October 17, 2013

On Monday, the Financial Industry Regulatory Authority (FINRA) published their Report on Conflicts of Interest (PDF) "to better understand how [a number of a large firms] manage conflicts of interest and to identify effective practices to manage those conflicts." The report details observations made in connection with FINRA's targeted examination letter in July 2012 as well as in-person meetings resulting from that letter.

The report makes it clear that a well-defined framework is necessary for effective management of conflicts of interest. Staff should understand their responsibility to identify conflicts of interest, and compensation packages should be structured so as to minimize potential conflicts of interest.

As new products develop, so to does the potential for new conflicts of interest. FINRA notes that firms "at the forefront of financial innovation are in the best position, and are uniquely obligated, to identify the conflicts of interest that may exist at a product’s inception or that develop over time." FINRA hit the nail on the head here since, in our experience, new products tend to breed the most egregious conflicts of interest.

The report also suggests augmenting a firm's code of conduct to include a "best-interest-of-the-customer" standard. Such a standard, if uniformly implemented, would go a long way toward increasing investor protection.

FINRA seems content with the progress made by broker-dealers so far, but notes that "[i]f firms make inadequate progress [to address conflicts of interest], FINRA will evaluate whether conflicts-focused rulemaking is necessary to enhance investor protection."

Wednesday, October 16, 2013

Shares of non-traded real estate investment trusts (REITs) were sold in large amounts during the real estate bubble of 2005-2007. Without an observable trading price, sponsors simply fixed the share price of non-traded REITs at $10 per share. As real estate markets have collapsed and now begun to recover, it has been difficult to ascertain just how much those $10 shares have changed in value. Non-traded REIT sponsors are now required to estimate per-share net asset values, which have indicated that several of them may face significant capital losses. However, such values are management estimates, and may not reflect market value.

A few non-traded REITs have merged with traded REITs, allowing investors to sell shares of the combined company. They often reverse-split their shares to make their per share prices higher, but in split adjusted terms, those IPOs sometimes reflect significant losses. Some, such as Chamber Street Properties (CSG) and Cole Real Estate Investments Inc. (COLE) have listed their shares directly.

Just last week, Columbia Property Trust (formerly known as Wells REIT II) listed its shares under the ticker CXP. After adjusting for a 4-for-1 reverse split, the per share value of CXP was just $7.33, a loss of over 25%. Compare this to the FTSE NAREIT Index of traded REITs, which has increased 28.4% since Wells REIT II started fundraising in December 2003 and 38.6% since June 2010, the last time shares were sold at $10. It raised approximately $5.9 billion in equity over that period.

Columbia Property Trust was the second largest non-traded REIT by total assets, but by no means alone in facing potential losses. Limited secondary market data suggests that some non-traded REITs have lost upwards of 60-70% on a per share basis. This may come as little surprise, as non-traded REITs are generally laden with upfront and ongoing fees which can erode investor value. We have noted these and other issues in our research paper on non-traded REITs.

Tuesday, October 15, 2013

As per rules adopted in line with the 2012 Jumpstart Our Business Startups Act (JOBS Act), hedge funds and other private placements can now advertise to the general public. We have been covering this issue extensively here on the blog. While many sources suggested that this would unleash an immediate flood of new marketing, several sources have noted that there has in fact been remarkably few hedge fund advertisements so far.

Why? There could be several reasons. The first is that while the SEC has relaxed their rules, other regulators have not. For example, the Commodity Futures Trading Commission still prohibits general solicitation for hedge funds that use derivatives extensively -- which could be a large fraction of the market.

Marketing and performance advertising is an inherently high-risk area due to the highly competitive nature of the investment management industry. Aberrational performance of certain registrants and funds can be an indicator of fraudulent or weak valuation procedures or practices. The [SEC] will also focus on the accuracy of advertised performance, including hypothetical and backtested performance, the assumptions or methodology utilized, and related disclosures and compliance with record keeping requirements.

Several hedge fund sources quoted in the financial media propose a third reason. They claim that advertising is seen as a sign of weakness amongst funds. One source in the Financial Times stated that big hedge funds are unlikely to advertise as "they think it is gauche and déclassé." Instead, by these accounts it is the smaller and less established funds that are most likely to use general solicitation to increase their investor base. If true, this bias towards smaller funds may lead to an equilibrium where the riskiest and least established funds are those that market most heavily to unsophisticated investors.

As we discussed over a year ago, a major concern with allowing general solicitation of private placement investments is that such investments tend to be highly speculative. As an example, we have found that sponsors of a private placement real estate investment called a tenants-in-common agreement (or TIC) tend to use aggressive and unrealistic assumptions in their return projections. These products also tend to involve the largest selling commissions, leading brokers and advisers to 'push' them on investors. This combined with the lifting of the general solicitation ban could lead to a proliferation of unsuitable or fraudulent investment schemes.

Monday, October 14, 2013

We see it again and again: complex investment strategies packaged into traditionally conservative investments. We have seen corporate debt linked to exotic derivatives positions (structured products), exchange-traded products linked to complex futures positions (commodities and volatility ETPs), variable annuities linked to options strategies (structured product based variable annuities), and even certificates of deposit with complex payoff structures (structured CDs). Now, we are seeing more and more mutual funds that use investment strategies typically only seen only in hedge funds. The difference, of course, is that while hedge funds can only be sold to accredited investors, shares of mutual funds can be sold to anybody.

InvestmentNews' Jason Kephart is reporting that Fidelity is planning to launch the Fidelity Event Driven Opportunities Fund, currently awaiting SEC approval. The fund will follow an 'event-driven' strategy, attempting to profit from corporate actions which could affect a company's stock price. According to the article, it will not take short positions.

Event-driven strategies are based on the idea that a company's stock price might become mispriced during a restructuring, merger, or other major corporate event. Event-driven traders will buy stocks they consider temporarily underpriced, and sell when that price 'corrects' itself. There already exists an event-driven mutual fund, The Arbitrage Event-Driven Fund (AEDNX), and several indexes.

FINRA has issued an Investor Alert on 'alternative' mutual funds, warning that investors "should be aware of their unique characteristics and risks." Also, FINRA notes that management, transaction, and other fees can be higher with more complex trading strategies than traditional buy-and-hold investments. While Fidelity is not alone in offering alternative mutual funds, it is interesting that a brand closely associated with fundamental investing would adopt this new approach.

Friday, October 11, 2013

According to the complaint (PDF), Rodrigo Terpins traded on nonpublic information concerning H.J. Heinz that he learned from his brother, Michel Terpins. Rodrigo Terpins made his trades through "a Cayman Islands-based entity named Alpine Swift that holds assets for one of their family members." The Terpins brothers and Alpine Swift, which was named as a relief defendant, have agreed to pay over $1.8 million in disgorgement to settle the charges. Additionally, they have agreed to a final judgment which permanently enjoins them from future violations of the securities laws.

Judgments were entered against Charles J. Dushek, Charles S. Dushek, and Capital Management Associates, Inc. for their involvement in a nearly $2 million cherry picking scheme. The judgment permanently enjoins the defendants from future violations of the securities laws and orders them to pay disgorgement, prejudgment interest, and civil penalties.

This September a Grand Jury indictment was obtained "against Jason Wynn and Martin Cantu for their role in a conspiracy to defraud prospective investors in a penny stock company that they controlled, ConnectAJet.com, Inc." According to the charges, Wynn and Cantu " issued several false public statements and advertisements that misled potential investors" to "artificially boost demand for ConnectAJet stock." The indictment charges Wynn and Cantu with violating sections of the Exchange Act. The charges in the "criminal indictment stem from the same misconduct underlying the Securities and Exchange Commission’s prior investigation of ConnectAJet and the Commission’s prior civil enforcement actions against Wynn and Cantu." In its cases against the defendants (SEC v Reynolds, et al. and SEC v. ConnectAJet.com, Inc) the SEC found the defendants guilty of violating various provisions of the securities laws and permanently enjoined them from future violations, barred them from participating in penny stock offerings, barred Cantu from "serving as an officer and director of a public company," and ordered them to pay over $10.4 million combined in disgorgement, prejudgment interest, and penalties.

The SEC charged Toby G. Scammell in 2011 with trading on insider information regarding Walt Disney Company's acquisition of Marvel. A final judgment was entered against Scammell in 2012 that imposed a permanent injunction against him and ordered him to pay disgorgement, prejudgment interest, and civil penalties.

On October 8, 2013, "a federal grand jury returned a criminal indictment charging Scammell with one count of securities fraud and one count of wire fraud based upon his trading in Marvel."

On September 26, 2013 the SEC "filed an action related to an elaborate stock manipulation scheme involving shares of China Energy Savings Technology, Inc. against Lee Chi Ling, as a defendant, and Perfect Genius Limited, as a relief defendant." Previously, the SEC charged "Chiu Wing Chui, Lai Fun Sim, Jun Tang Zhao, Lee, and others acting in concert" with orchestrating the scheme. According to the SEC, Lee and entities under her control, including Perfect Genius, "furthered the fraud by: (i) receiving shares of China Energy directed to her by the Chiu Group; (ii) selling some of those shares to profit from artificially high prices...and (iii) acting as nominees...which concealed the illegal trading in the shares of China Energy."

The SEC has charged Lee with violating sections of the Securities Act and Exchange Act and seeks disgorgement, prejudgment interest and the return of ill-gotten gains from Perfect Genius.

A judgment was entered against Johnathan Fraiman for allegedly participating in "a boiler room operated by Edward M. Laborio." According to the SEC, "Fraiman, Laborio, Matthew K. Lazar, and seven entities owned and controlled by Laborio, including a non-existent hedge fund...rais[ed] up to $5.7 million from...investors through the fraudulent sale of five unregistered offerings." Fraiman was allegedly hired by Laborio in 2008 to "to market Envit Capital Multi Strategy Mixed Investment Fund I LP, a purported hedge fund that in reality never conducted any business." Fraiman allegedly "raised hundreds of thousands of dollars for Laborio by misrepresenting the historical returns and financial health of the Envit Companies." The final judgment enjoins Fraiman from future violations of the securities laws, imposes a penny stock bar against him, and orders him to pay over $205,000 in disgorgement and prejudgment interest. However, payments of disgorgement and prejudgment interest have been waived based upon Fraiman's financial condition. Fraiman also consented to be barred for 10 years from "any future association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization."

Final judgments were entered against brothers, Thomas and James Mulholland, for using false and misleading statements to"[offer] and [sell] approximately $2 million of demand notes...to fund [their] failing real estate business." Additionally, the SEC has charged the brothers with acting as unregistered broker-dealers. James and Thomas Mulholland have consented to a final judgment that permanently enjoins them from future violations of the securities laws, and orders them to pay over $1 million combined in disgorgement, prejudgment interest, and civil penalties.

Final judgments were entered against Tai Nguyen and ThanhHa Bao in SEC v. Nguyen et al., for trading on matertial non-public information concerning Abaxis, Inc. securities. Nguyen traded on the information that he learned from his sister, Bao, who at the time was an employee at Abaxis. Nguyen reaped over $144,000 in illicit profits from the trading. The defendants have consented to final judgments that order them to pay over $458,000 combined in disgorgement, prejudgment interest, and penalties, and permanently enjoin them from future violations of the securities laws.

In a parallel criminal case, Nguyen was sentenced to a year of incarceration.

A final judgment was entered against China MediaExpress Holdings, Inc. for engaging in a scheme "to mislead and defraud investors by, among other things, grossly overstating [its] cash balances." The final judgment permanently enjoins China Media from future violations of the securities laws and orders it to pay over $49 million in disgorgement, prejudgment interest, and civil monetary penalties.

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